Retirement and Social Security Reform
Recovery With More Bang for the Buck
The Washington Times
December 17, 2002
By Ernest S. Christian and Gary Robbins
President Bush will soon ask the new Congress to act quickly
on a package of tax changes designed to revive a flagging
economy. Achieving that goal involves more than swapping a
dollar of lower taxes for a dollar of higher deficit. Instead
of just "cutting taxes" in a generic sense, the
idea is to change those parts of the tax code that impede
economic growth far out of proportion to the amount of tax
revenue they raise - in other words, those that do more harm
Also, the correct choices need to be made among the several
potential tax changes that produce a lot of economic growth
for relatively little revenue cost. Priority should be given
to those remedies most directly related to the particular
ills from which the economy is now trying to recover.
Step One on the road to recovery should be to stimulate business
investment in capital goods. After all, it is a lack of business
purchases, not a lack of consumer spending, that has characterized
the current economic doldrums. Consumption has continued to
grow for the past two years. But, investment has actually
fallen. As a consequence, the growth rate in gross domestic
production has declined by a whopping one-third.
The best way to encourage a business to make a capital goods
purchase is simple: First, reduce the price the business must
pay for the capital item and, second, help finance the purchase.
The best tax change to accomplish this double whammy is also
simple: Allow the business to deduct the full cost of capital
goods in the year of purchase instead of requiring it to defer
depreciation deductions into the future. For example, allowing
full first-year expensing reduces the after-tax cost of a
new high-tech machine tool by 4 percent. Further, the company
that purchases the machine for, say, $1 million, would have
a tax deduction worth $350,000, which it could immediately
"take to the bank" to help finance its new capital
Cash-flow help in financing capital goods purchases is important
to all business, but is vital to the vast array of "middle
class" companies who are not ultra large, but are not
necessarily small either. Many of these companies make big-dollar
capital investment as fast as they can afford it. They grow
very rapidly, often quickly doubling in size, and, in a broad
sense, create most of the new jobs in the United States.
As a remedy for what ails the economy, first-year expensing
ought to be a slam-dunk. It enjoys bipartisan support in the
Congress, is correct tax policy that moves the tax code one
step closer to tax reform and, among all alternatives, provides
the highest bang-for-the-buck boost to the economy.
Because capital goods purchases by businesses increase worker
productivity and wages, first-year expensing is probably the
only "business tax cut" that can garner a large
bipartisan majority in both the House and the Senate. Further,
because first-year expensing just moves forward in time deductions
that would be allowed later anyway, the long-term budget cost
is close to zero - even though, during the official 10-year
budget window, expensing can get a little costly. The way
to hold down the budget impact, while still providing an ample
boost to investment, is to enact first-year expensing only
for a temporary period. For example, allowing first-year expensing
for all capital goods orders between Jan. 1, 2003 and Dec.
31, 2005 would have a total 10-year budget cost of less than
The best companion for first-year expensing - on the road
recovery and on the road to tax reform - is to exclude dividends
paid by corporations from the second tax presently payable
by shareholders when they receive the dividends. Today, when
a corporation earns $1, it pays a 35 cents tax. If it then
distributes a 65 cents dividend to a shareholder, that shareholder
is often required to pay an additional 39 percent tax on the
dividend. After paying all this tax, there is only 40 cents
left out of the original dollar.
Because of a nearly confiscatory 60 percent double tax, dividends
have almost gone out of style over the last several decades.
From the corporation's standpoint, it has been better to retain
cash, even to the point of going out and acquiring some other
line of business, rather than a large portion of the cash
going to the government when the shareholders receive a dividend.
From the standpoint of a shareholder, it has been better to
buy stock of companies that "project" large earnings
in the future and, then, to sell the stock and pay a tax on
the profit at a maximum 20 percent capital gains rate.
As recent scandals have illustrated, excessive reliance on
the "projected earnings" puts enormous pressure
on a company's financial accountants as well as its own internal
financial management. In contrast, investors can be pretty
well certain that a cash dividend represents real earnings
and real money.
Eliminating the second shareholder-level tax on dividends
would greatly increase the real rate of return on all dividend-paying
stocks. For example, a dividend-paying stock that had provided
a 3 percent tax yield would all of a sudden yield 5 percent.
Higher yields will give a major boost to stock values, thereby
adding to wealth in the economy. Each dollar of tax relief
for dividends will boost the economy by roughly $2.70, even
after taking into account that dividend tax relief applies
to old capital as well as to new and, therefore, has a relatively
high revenue cost.
Taken together, dollar-for-dollar, first-year expensing and
dividend tax relief are the perfect synergistic combination
to restart the economic engine quickly and keep it going for
the long term. Both are mainstream tax reforms with impeccable
policy credentials. Now is the time to enact them both.
If a choice must be made, first-year expensing should come
first. It rewards only investments in new capital, therefore
providing the largest bang for the buck, and is most clearly
and immediately related to higher worker productivity and
Ernest S. Christian is a Washington lawyer who also works
with the Center For Strategic Tax Reform. Gary Robbins is
president of Fiscal Associates and a visiting fellow in tax
policy at the Heritage Foundation.